Op-Ed: Do We Really Need, or Want, the ‘Utility of the Future’?

A hybrid utility (part monopoly, part non-monopoly) is in no position to best serve subscribers or shareholders

Fred Fastiggi

Recent discussion about and promotion of the utility of the future raise interesting questions. Few would argue that a regulated rate of return provides the best alternative for sustaining critical infrastructure in a natural monopoly like transmission and distribution (T&D), but is including efficient energy end-use conversion under a regulated framework the best way to coax innovation and lower consumer costs from an evolving industry? More importantly, is it the best way to ensure the future safety and adequacy of our critical power-delivery infrastructure?

Someone, somewhere sold the idea that electric utilities should be run like a competitive business. Unfortunately, with utilities constrained to operating in franchise areas, this becomes difficult when demand for service is a function of growth in population and the local economy. Recognizing those limitations, diversification became an antidote.

Power generation, renewables, equipment leasing, and efficiency became some of the avenues for utility diversification though the drivers and characteristics of these businesses differ significantly from that of electric transmission and distribution companies. When these businesses are operated in a regulated framework their maturation inevitably becomes stunted with higher cost and slower development of functional capability. Just the opposite of what one might expect as a natural outgrowth of competition and the innovation it facilitates.

Underlying conflicts

Competition requires multiple suppliers, with none having unfair advantages such as risk-free capital while using “other people’s money.” Underlying conflicts also evolve when the service one promotes (such as efficiency), results in a decrease in the sale of other services one provides (kilowatt-hours). With those conditions present, competition cannot exist.

Increasing shareholder value is the goal of every publicly traded company, and today, compensation programs for executives are often skewed toward how well management grows shareholder value. But is this the best arrangement for entities that provide an essential service and whose performance determines our quality of life — and perhaps even more?

“Imagine a blackout lasting not days, but weeks or months. Tens of millions of people over several states are affected. For those without access to a generator, there is no running water, no sewage, no refrigeration or light. Food and medical supplies are dwindling. Devices we rely on have gone dark. Banks no longer function, looting is widespread, and law and order are being tested as never before.”

“It isn’t just a scenario. A well-designed attack on one of the nation’s power grids could cripple much of our infrastructure — and in the age of cyberwarfare, a laptop has become the only necessary weapon.”

Just a few years ago, many would have dismissed Mr. Koppel’s writing as a delusional rant, but given recent prolonged power outages, many of us have firsthand experience with the disruption of protracted blackouts. Fortunately, these outages were isolated to smaller parts of the United States, where responders concentrated national resources to restore power quickly, or to warmer climates where there was little chance of extended, temperature-induced hardship. The consequences of a lengthy loss of power at the wrong time of year in regions like those served by PJM, wouldn’t end as harmlessly.

The hybrid power utility: How did we get here?

The primary driver of shareholder value is consistently increasing future cash flows through appreciation in share price or dividends. While growth in cash flow may be an appropriate goal for companies in competitive marketplaces, when forced on electric utilities whose growth prospects are limited due to operating in mature territories, they can be lured into focusing on competitive ventures rather than the critical infrastructure that customers expect them to operate reliably.

Utility management has addressed constrained growth prospects through diversification into seemingly related, but traditionally unregulated areas while simultaneously demanding “regulated” treatment. Hence the emergence of the hybrid utility (part monopoly, part non-monopoly). Recent examples of diversification are the current forays into “energy efficiency” (activities that facilitate the conversion of delivered electricity into functional end-use forms like heating, cooling and lighting). Electric utilities demand, and receive, risk-free returns on their investment in customer energy upgrades, although this is hardly classified as a natural monopoly.

The greatest competitive strength of an electric utility isn’t in being a low-cost provider, innovator, or provider of outstanding service. By necessity, and in the interest of self-preservation, their strength is their ability to shape legislation and regulation in a manner resulting in favorable laws, rulemaking, and programs that provide attractive earnings for shareholders. One need only look at the creeping but steady reregulation/subsidy of non-monopoly businesses in the energy space (renewables, efficiency, and now even nuclear generation) for evidence of the hybrid utility’s brilliance in chipping away at previously accepted deregulation concessions. Current suggestions that subsidized efficiency programs be a condition for decoupling electric rates further illustrate aggressive expansion into nonutility roles.

Schemes that have little to do with essential services

Utilities dedicate their best resources to selling labyrinthine schemes that have little to do with supplying essential services. Ironically, electric deregulation originally came about only after lengthy negotiation resulting in electric utilities gaining generous concessions with the enthusiastic support and leadership of the same executives, lobbyists, and lawyers who today argue for regulated treatment on the nonutility business they sought to free from regulation a few years ago.

Electric utilities have protected territories selling essential service where customers have no latitude to switch suppliers. They have guaranteed customers and service demand occurs in predictable patterns. The primary challenge they face is how efficiently they operate their T&D systems. Nevertheless, their pricing results in generous returns. Their risk profile is no different than that of a bridge and tunnel authority or a municipality providing water and sewer services. Yet coupon rates on bond issues from municipalities or authorities, even allowing for tax benefits, rarely approach the regulated returns of electric utilities.

Electric utilities in fully developed territories that promise the investment community they will increase dividends by X percent or revenues by Y percent are increasingly dependent upon earnings from unregulated assets or attaining higher returns on regulated assets. Under these conditions, both businesses such as generation, efficiency, and renewables that are increasingly larger components of hybrid portfolios and regulated services are priced higher and delay improved levels of service and performance.

Holding companies with both regulated and unregulated assets are engaged in internal competition for capital and corporate resources. Conflicts naturally emerge when hybrid electric utilities have the divergent goals of providing safe, reliable T&D services while also requiring growth in earnings.

How do we fix it?

The hybrid electric utility model isn’t suited to serving a public that is increasingly vulnerable to the potentially catastrophic consequences of grid instability, as well as cyber and physical attacks, an area that ideally should demand full corporate focus. Spinning off elements of diversified electric utilities that shouldn’t be in a regulated structure, and concurrently restructuring balance sheets for the remaining true monopoly assets with bond-like financing can facilitate a more secure grid, accelerated innovation, and lower pricing for both deregulated energy services and T&D.

An alternative approach that focuses on the development and maintenance of resilient T&D infrastructure, while letting generation and efficiency businesses evolve in a competitive marketplace is worth considering. Unregulated spinoffs should include generation, renewables, end-use energy conversion, and all businesses that aren’t natural monopolies. They should be left to evolve on the merits of their own value propositions and management efforts without ratepayer subsidy.

Unregulated offspring of today’s hybrid utility shouldn’t be prohibited from investing in efficiency, generation, or renewables, but there is a more equitable, logical, and economical avenue for their participation.

It may be time to ask do we really need, or want, the utility of the future?

Principal and managing director of Shoreline Energy Advisors, LLC, Fred Fastiggi has almost three decades of experience working in the power and energy sectors.